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Compensation consolation

From April next year, the Financial Services Compensation Scheme will have a new funding model which could lead to IFAs paying less than they do now.

In March 2006, the FSA announced a review of funding for the FSCS in order to ensure the funding of the scheme was fair and proportional and, most important for the regulator, sustainable.

At the time, FSA managing director David Kenmir said: “We hope to design funding arrangements which apportion the cost of compensation between regulated firms as fairly as possible.

“Discussions about this issue tend to focus on today’s problems such as endowment misselling but the scheme must also be capable of providing compensation for tomorrow’s problems.”

In the discussion paper that was launched, the FSA set out several options for the future funding of the FSCS. First, firms would be divided into five categories according to the type of business they are involved in. These categories are: life and pensions; securities, mutual funds and derivatives; deposits; general insurance; and mortgages.

These five categories are the same for all the options proposed.

The first option proposed was for firms operating within each category to pay towards compensation claims arising from that area of business. Each categories would stand alone, with no cross-subsidy between them.

The second option proposed a general pool of funding, in addition to the five broad classes, and this would act as a reserve in the event of catastrophic losses in any one class.

The third option was for the creation of subclasses within in broad business class but without a general pool of funding to act as a reserve.

The final option was for a system of sub-classes within each of the five broad classes and a general pool as well.

Despite initially leaning towards the second option, the FSA has come up with something very similar to the last of the initial options.

The structure for the new funding system will see the five broad business classes remain and each of these, with the exception of deposits, will have two sub-classes within it. Finally. above this there will be the general pool.

The cost of claims will initially be met by the relevant sub-class, up to an annual threshold, with any further claims met by the general class.

Only in the event of “significant default, or series of defaults” would the costs of compensation then spill over into the general pool.

The FSA says it expects that the new system will increase the capacity of the FSCS to meet compensation claims to £4bn a year.

FSA director Graeme Ashley-Fenn says: “The new model is more rational, fairer to the various players in the market and provides greater levels of funding. It will be capable of meeting current issues, such as endowment misselling, and will now also provide compensation for any future potential and unexpected claims.”

Aifa welcomes the reform of FSCS funding. Deputy director general Faye Goddard believes the scheme was in need of urgent reform. She says: “Aifa has lobbied for reform on behalf of its members for a number of years and we are pleased with this outcome. The new model is structured in a way that should see fairer distribution of costs across all parts of the financial service industry and provide better levels of consumer protection.”

What will this mean in practice for IFA firms? The changes should mean that the FSCS levy will be dramatically reduced for IFAs. MM Financial Management IFA Miles Moseley says: “If it reduces the levy, then I am in favour of it. Anything that ends up with IFAs paying less is a good thing.”

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